October 20, 2023 | 13:08
BoC Preview: Let Time Do the Work
The Bank of Canada is widely expected to hold policy rates steady at the October 25 announcement. This week’s data sealed the deal, with the BoC’s Business Outlook Survey (BOS) weakening sharply and September inflation surprisingly tame. The latest data suggest that the weakness seen through most of the first half of the year continued into the second half. While inflation remains too high, there’s been a steady deceleration which can be expected to continue given the soft economic backdrop.
The Bank of Canada highlighted four things that it’s watching: “excess demand, inflation expectations, wage growth and corporate pricing behavior”.
Excess demand: The July MPR estimated the output gap was between 0% and +1%. That was when Q1 GDP growth was +3.1% and the BoC projected Q2 to be +1.5%. Since then, Q1 was revised down to +2.6%, and Q2 contracted 0.2%. Combined, GDP growth is 2.2 ppts below where the BoC thought. And, the Q3 BOS suggested that there was little rebound in the quarter, though the reversal of some temporary factors could provide some one-time support. Given the GDP revision/miss and likely ongoing weakness, the output gap is near-zero or has moved into negative territory for the first time since late 2021/early 2022. An increasingly negative output gap is disinflationary, signalling that policy rates don’t need to rise further.
Inflation expectations: The BOS and Consumer Expectations Survey showed inflation expectations retreating in the latest quarter. The levels remain elevated, but it’s not reasonable to expect a sharp move back to 2%—the adjustment lower will take time. The improving trend suggests rates are doing their job, but still-high levels mean rate cuts remain a distant prospect.
Wage growth: This is the one issue that will likely be highlighted as an ongoing concern for policymakers. Most wage metrics continue to show growth in the 4%+ range which, given zero productivity growth, is not consistent with the 2% inflation target. While firms are expecting wage pressures to ease in the coming quarter, consumers continue to anticipate hefty increases. The BOS also highlighted that while hiring and wage pressures look to ebb, firms aren’t planning layoffs. The jobless rate is up 0.6 ppts from the lows of last year, but it’s clear that further slack is needed to cool wage growth. Perhaps that will come as the economy softens, but we’re not there yet, and that will be a driver of discomfort for policymakers.
Corporate pricing behaviour: The BOS is one of the few sources of data on this topic, and it showed some modest improvement. Corporations are changing prices a bit less frequently than in the prior quarter, maintaining a downtrend. However, the size of price changes didn’t decline. Still, “signs indicate that pricing behaviour is moving toward normal”. One more reason for the BoC to believe it has done enough.
This meeting will be accompanied by a Monetary Policy Report and updated forecasts. On growth, look for Q3 to be downgraded into the 0.5%-to-1% range from 1.5% previously. The first estimate on Q4 will likely be around zero. With the mid-point on 2023 potential growth at 2.3%, anything around our expectations would point to further disinflationary pressure. On inflation, the BoC’s Q3 forecast of 3.3% y/y was well below the actual of 3.7%. However, the softer growth outlook should at least offset the Q3 CPI miss and keep inflation on a path toward 2% over the next 12-24 months. For Q4, a likely sharp deceleration in October (due to base effects) points to an average in the low/mid-3% range. Inflation is still too high (maybe the BoC will make a theme song out of that phrase) for comfort, but moving in the right direction (lower).
Key Takeaway: Most data points suggest that the Bank of Canada has done enough and should be moving firmly to the sidelines. While inflation is still well above target, which will keep the BoC talking hawkishly for now, it is a lagging indicator, and the weak GDP growth outlook points to further disinflation ahead. Assuming growth doesn’t stage a surprising comeback, the Bank of Canada should be increasingly comfortable keeping policy rates steady.